When Will the Music Stop for Government Bonds? 37 comments
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You don't take a very responsible job at a time like this and jump after eight months to make money in the private sector.
- Anonymous "Senior City banker" quoted in The Financial Times after John Kingman of UK Financial Investments said he was stepping down.
This response would seem to indicate that a) banking itself is irresponsible; b) the anonymous banker explicitly acknowledges he himself is in it for the money; c) bankers still dominate the field in the hypocritical delivery of advice to others; d) the coinage "banker" has now completely replaced its assonant rival as a term of abuse to describe the hopelessly objectionable and contemptible.
The great Austrian economist Ludwig von Mises had the final word about a terminal credit crunch:
There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved (Mises, "Human Action", 1949).
But there is an almost insurmountable problem in viewing the investment markets through the rigid and unforgiving prism of the so-called Austrian school. Mises wrote of the world as it should be. We live in the world as it is. Our own investment markets, or at least those of the supposedly developed west, are now government-directed parodies of free markets – having theoretically been at economic war with socialism and communism, and having seemingly triumphed as the Berlin Wall fell, the governments of the west have now adopted much of the socialist-driven command economy model that they had ostensibly vanquished as recently as 1989.
CLSA's Russell Napier has written well of these challenges in otherwise implementing an Austrian resolution to the banking and credit crisis. The challenges are both political and cultural, and as such, trying to finesse timing issues whilst navigating the murky swamp of moral hazard that currently buoys up the banks is probably close to impossible. In his June research note, "How the rally ends", he points out that the:
long-awaited “Austrian moment” produced nationalisation rather than creative destruction. The next cycle will now be dominated by a government owned / directed credit cycle triggered and sustained by fiscal profligacy. The ultimate result of this will be that the true creative destruction will come, eventually, through the government debt markets. Given the government's willingness to jump into the credit breach, the great US credit supercycle can only end with the collapse in the credit quality of the US government itself. Then, and only then, can we witness the much awaited creative destruction.
In a bid to ensure its own survival, the US government has reacted to this otherwise Austrian moment of truth:
by turning water into apparent wine and turned US commercial credit risk into sovereign credit risk. Starting with Freddie and Fannie and spreading to the entire banking system and even the automobile sector, huge swathes of commercial credit have been given sovereign credit status. That support is being passed on through nationalised financial institutions to the residential property market and beyond. Creative destruction in the form of depression and deflation were judged to be politically unacceptable. The democratically elected governments of the world have put themselves in the way of creative destruction but the cost is escalating government debt to GDP ratios. So the key question is not how creative destruction will work in the private sector but how the markets will wreak creative destruction on the private sector through the government debt markets.
As the quote that begins this piece makes clear, those at work in the banks continue to take no responsibility for their actions and indeed may be well placed to benefit from the suspension of normal market mechanisms and the extraordinary degree of explicit government support. But if any other sector in society behaved this way, underwritten by taxpayers who typically enjoy a fraction of their government-backed rivals' remuneration, they would quickly find themselves hanging from lamp-posts by piano wire. The banks would be well advised to divert even a tiny fraction of the sums being allocated toward unwarranted bonuses to some decent public relations advice.
Although Napier's thesis looks apocalyptic, at least for holders of western market government bonds (and it probably will be), the frustrating question of market timing remains. His conclusion is that, on the basis of previous historic examples, equity markets can continue to bloom unless and until inflation approaches a level around 4% and the yields on 10 year Treasuries start to threaten the 5% to 6.5% range. Again, anticipating the timing of such developments is necessarily and inevitably problematic. It seems reasonable to conclude that, in the context of a colossal ongoing asset deleveraging and debt deflation, inflationary pressures will be modest for some time to come. So it is not yet time conclusively to abandon western government debt for something more genuinely secure. Diversification among high quality debt assets, on the other hand.
Fund managers Eric Sprott and David Franklin in June 2009 ("The Solution... is the Problem") pointed out that owners of US government debt as of September 2008 would have to buy three times the debt that they bought in 2008, by September 2009, in order to balance the US accounts. As they observed, given the fragile nature of the economy “it seems frighteningly apparent that a threefold increase in debt purchases by [current bondholders] is a mathematical impossibility.” The problem, including timing, is complicated by the involvement of foreign participants, who now account for over 50% of the ownership of US Treasuries. Their involvement goes beyond purely investment objectives, in that their US Treasury holdings are the primary manifestation of their desire to manage their foreign exchange reserves in order to keep their domestic currencies “competitive”. Their place in the creditor role nicely diversifies the economic ownership pot, but it also makes the possibility of ultimate repudiation of that debt more likely.
And the threat of repudiation (or default) is no idle possibility. Napier highlights the lamentable history of US debt to GDP ratios over recent years, which now challenges the levels incurred during and after World War II, as the chart below makes clear:
Cited by CLSA Asia-Pacific Markets, "Solid Ground – How the rally ends", June 2009.
But the moment of crisis may be some way off. The immediate future path of the US dollar may also pleasantly surprise critics. As Napier observes:
The move to easier monetary policy in the US has not resulted in a collapse in the dollar as the rest of the world has also been forced to much easier monetary policy. A steady dollar reduces inflation risks, encourages foreigners to buy Treasuries and would likely facilitate further quantitative easing if necessary.
At a recent seminar, Napier suggested that the ultimate equity bear market low – triggered by a collapse in US Treasury prices (and a concomitant spike higher in Treasury yields) might not arrive until 2014 or so. In any event, as indicated, the issues of anticipating such timing – not least being influenced by massive political and cultural considerations – are just too difficult to call. But just because a dire situation (US government indebtedness – and let's not pretend that much of the developed world doesn't share that same vast, leaky boat) has become demonstrably more dire over recent years does not mean that the deterioration can persist indefinitely. As Herb Stein once said, if something cannot go on forever, it will stop. When the music finally stops for (US) government bonds, will you really want to be holding any? Monitoring inflation trends over the coming months and years promises to be more than usually exciting.
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This article has 37 comments:
I think it is obvious that the John Kingman did not leave UKFI simply to make money in the private sector - something spooked him, but was it too much government interference or a realization of how bad the assets on its book are...
I would only point out out that except from a Mellon liquidationist way, this does not offer any viable solution to the dire predicaments that western societies (+japan) do now have to confront.
And please remember where the Mellon-Brüning medecine did lead lead Europe into in the 30s.
You would not want that to be repeated anyway, anytime !
Best Regards.
The limit, of course, is the debt service, when the marginal tax dollar is spent on interest payments there is no necessary crisis. No, there is still room to invent. For example, Argentina confiscated the pensions of its citizen, then taxed farm exports, and wants now to own a lien on all private property as surety on state debt.
The distortions of evil finance are as unlimited as the mind of man to believe that he is secure in his debtors. This soon becomes a fantasy game in which the winner is the more gullible player.
This is the game of democracy in which the few have the power to take from the many until there is nothing left but the bigger fool, and he loses!
Japan is a good example of that. The Japanese government keeps issuing even more government bonds relative to their GDP than USA has been issuing until now. And their bond prices aren't collapsing because Japanese citizens are saving their earnings like crazy and buying Japanese government bonds.
When a country relies on foreigners to fund its deficits. Then such funding is insecure. But if the country's own citizens begin to save more and buy more of their government bonds. Then such funding is secure for as long as the people keep saving. This won't last forever. But domestic savers will probably keep buying US government bonds longer than foreign investors would.
On Jul 30 04:14 AM Nick36 wrote:
> Perhaps people in USA will increase their saving rate a lot due to
> lack of economic growth. And they will keep buying US government
> bonds for the foreseeable future. Which might mean that the collapse
> of US bond prices might be a very long way away.
>
> Japan is a good example of that. The Japanese government keeps issuing
> even more government bonds relative to their GDP than USA has been
> issuing until now. And their bond prices aren't collapsing because
> Japanese citizens are saving their earnings like crazy and buying
> Japanese government bonds.
>
> When a country relies on foreigners to fund its deficits. Then such
> funding is insecure. But if the country's own citizens begin to
> save more and buy more of their government bonds. Then such funding
> is secure for as long as the people keep saving. This won't last
> forever. But domestic savers will probably keep buying US government
> bonds longer than foreign investors would.
The position of the US and UK is very different to that of Japan in the 90's.
There savings rates were real, so Government debt was countered by people not spending all of their money.
In the West now the 'savings' which are occurring are just people reducing their leverage and degree of indebtedness to some degree.
I also enjoyed your accurate and well-thought-out response to Eric36 in which you said:
"Treasuries is entirely dwarfed by intragovernmental holdings (42% of the market)"
Unwittingly, however, you have introduced a counter-argument to the conclusion of your article.
Rather than private savers taking up the slack, what if the Fed Govt takes up the slack by purchasing more of its own T Bonds for the benefit of the Social Security Trust Fund (SSTF) ??
The justification is there, because the electorate knows that the SSTF is technically insolvent. The increased purchases can be accomplished by an increase in the payroll tax for SS.
This solves two problems: The Ponzi scheme known as the SSTF can be further perpetuated by forcing more contributions into the scheme and the T bond market can be further propped up - and by extension mortgage rates kept low.
I am just curious as to your thoughts on that scenario?
Now I hear about him all the time. Of course they might have been talking about him at the Club Rendezvous in Vienna's Graben when I was in the American army and occasionally visited the place, although for the most part I wasn't in condition to know..
Also want to point out that Russell Napier is fantastic!
On Jul 30 10:36 AM Ferdinand E. Banks wrote:
> There it is again - adoration of von Mises. Hmm. I begain teaching
> economics in the l960s. I held professorships in a dozen universities,
> probably went to hundreds of seminars presided over by persons from
> every country and corner of the political spectrum, some of them
> brilliant and some hopeless, and read I dont know how many hundred
> articles dealing with macro in 'learned' journals. And so on and
> so forth. I don't remember a single mention of von Mises - although
> I'm sure that there must have been one from the windbags holding
> forth at some of these meetings, and also don't remember any of my
> students wasting my time with talk about 'Austrians'.
>
> Now I hear about him all the time. Of course they might have been
> talking about him at the Club Rendezvous in Vienna's Graben when
> I was in the American army and occasionally visited the place, although
> for the most part I wasn't in condition to know..
I am NOT talking about the Fed buying IOUs from the SSTF - I am talking about the other way around - the SSTF buying bonds (IOUs) from the Treasury.
On Jul 30 10:46 AM Jimbo wrote:
> Living4Divi: It is my understanding that the "IOUs", created by Congress
> and placed in a SS file cabinet in West Virginia, are Non-negotiable.
> If this is correct, would the FED be able to buy them ??
On Jul 30 11:09 AM Tim Price wrote:
> What's so wrong about intellectual respect for someone worthy of
> it ? Better, surely, than respect - of any kind - for the banksters
> and politicians who collectively landed us in this unholy mess. And
> the exquisite irony is that Mises seems to have suffered the fate
> of the prophet wholly unloved in his own land. As I tried to make
> clear, there's the world as it would be under the Austrian School
> - and the world we actually inhabit. But we can at least dream..
>
"I held professorships in a dozen universities"...might be part of your problem.
You've just admitted that you missed a major school of economic thought. Time for some serious reflection as to how active you really were during your career.
Instead of "hate'n" try exploration, discovery, and learning. It is never too late--even at an advanced age.
But what happens when their desire for more goodies is dampened by reality? To a large degree, living for today and letting tomorrow somehow take care of itself has been the norm for too many people.
A generation or two who have been able to buy what they want when they want will throw a collective temper tantrum and I am very afraid of the consequences not only from individuals but from further government intervention.
On Jul 30 10:25 AM Jerry baldy wrote:
,
> I do not think our population is willing to reduce their life styles
> to the degree required to pass thru these cuircumstances. Thus remedies
> that may not be conventually acceptable will have to be considered
On Jul 29 09:44 PM whidbey wrote:
> The logic is Simon pure, the sense of history exquisite, but the
> conclusion that this farce can not be stretched well into the future
> is a miscalculation of the capacity of man to believe whatever he
> chooses to believe.
>
> The limit, of course, is the debt service, when the marginal tax
> dollar is spent on interest payments there is no necessary crisis.
> No, there is still room to invent. For example, Argentina confiscated
> the pensions of its citizen, then taxed farm exports, and wants now
> to own a lien on all private property as surety on state debt.
>
>
> The distortions of evil finance are as unlimited as the mind of man
> to believe that he is secure in his debtors. This soon becomes a
> fantasy game in which the winner is the more gullible player.
>
> This is the game of democracy in which the few have the power to
> take from the many until there is nothing left but the bigger fool,
> and he loses!
Mises was for capitalism and individual rights.
Look at states who are exerting their influance over private companies to find fascism. It is not hard to find these days.
Given the state of the economy shouldn't the term be "tanker"? However, many blame W for the current mess.
And if the above sentence doesn't set your head spinning it isn't screwed on right.
Picture a room with ten guys in it, the first of whom has one dollar. First guy lends the dollar to a second guy for a one dollar promisory note. First guy then lends the promisory note to a third guy for ANOTHER one dollar promisory note. Everyone in the room suddenly gets an idea. They put the dollar in the middle of the table, and then they all start lending more and more promisory notes to each other until suddenly, there are trillions of dollars worth of promisory notes in the room. Each guy is worth billions on paper, and feels brilliant and rich. How long can this game go on, you ask? Answer? How much fun is everyone having?
Maybe one guy decides enough is enough, cashes in a promisory note for that one dollar sitting on the table, and walks out. The lending game might continue a while longer, until those poor nine guys in the room realize they are all completely insolvent. Anarchy follows. This is the gist of this article.
Meanwhile, the clever fellow who took that dollar and flew the coop is walking down the street realizing he's gone from being a multi-billionaire to being a guy with one lousy buck in his pocket. How long before he reconsiders, walks BACK into the room (to open arms and friendly pats on the back), slaps that dollar right back on the table and gets the music playing again? I give it three months, tops. We got a taste of that during the credit crunch.
Now assume that there are big burly government dudes waiting at the door, whose task is to prevent any of the ten guys from taking the dollar off the table and leaving the room.I think we got a taste of that, too, last year. Now I'm guessing the music won't stop until someone is clever enough to come up with a better tune, and clever enough to convince everyone (including the burly government dudes standing at the door) that he has done so. That happens once every three to five hundred years, more or less.
"The author made a very astute remark that our economy has not been able to support the Public and Institutional financial aspirations for decades now. This is a result of the dimunition of the world War II boom and post War american inovation and growth. This is another reason we must use our debt capacity now for future growth. Even if it does not work we will end up with the same pain at this point. to see a partial solution to our problem see bettertomorrow-holymol... This is intended as a part of larger thought but it is a start and can help. It is time we stop discribing the problem a begin to fix it. Even with the mistakes we certainly will make."
Yes!
We are in the secular decline part of the Kondratieff cycle. Innovation is the only way out. Too bad we under spent on research in the good years.
One of the central tenants of the Austrian School is that inductive reasoning, statistical mathematics and econometrics cannot give good answers; only posthoc deduction can be used to develop principles of economics. This idea implies testability of economic theory is impossible. This is a severe issue because modern scientific philosophy insists that testability is a requirement for the scientific method. This thesis of the Austrian school also gives rise to the criticism that it fails another basic requirement for the application of the scientific method, falsifiability.
So long as the Austrian school sticks to these basic tenants it will never be useful as a scientific basis for improving the understanding of economics.
On Jul 30 12:10 PM Hot Richard wrote:
> Ferdinand,
> "I held professorships in a dozen universities"...might be part of
> your problem.
>
> You've just admitted that you missed a major school of economic thought.
> Time for some serious reflection as to how active you really were
> during your career.
>
> Instead of "hate'n" try exploration, discovery, and learning. It
> is never too late--even at an advanced age.
So, look at history, for a guide.
Then, look to see what, if any inputs may change, but spread your view wide.
If, nothing significant is likely to come into play, then you can count on similar outcomes.
However, if there are significant variations in inputs, then how may that affect the outcomes?
In current circumstances, there are at least two very significant once in history additional factors, Peak Oil & Peak Population (total & Aging).
Due to those factors, "this time will be different".
Foreign bonds? EM debt? which ones? gold? other metals? And what time line? and Why.
That is the beauty of Austrian economics - it is the product of intelligent men who recognize the limits of their own capability in that they could never plan economic output better than a million individuals doing it on their own. This was an excellent article, and the most important line: "Mises wrote of the world as it should be. We live in the world as it is. Our own investment markets, or at least those of the supposedly developed west, are now government-directed parodies of free markets"
On Jul 30 08:29 PM bricki wrote:
> The Austrian school is generally considered a heterodoxical school
> outside mainstream economic theory. It is not at all surprising that
> a modern theoretician would have never run into Mises' work or anything
> associated with the Austrian school. Very few places teach the theory
> and publications on the topic are rare. In a lot of ways the relationship
> between modern economics and the Austrian School is similar to the
> relationship between modern biology and creationism.
>
> One of the central tenants of the Austrian School is that inductive
> reasoning, statistical mathematics and econometrics cannot give good
> answers; only posthoc deduction can be used to develop principles
> of economics. This idea implies testability of economic theory is
> impossible. This is a severe issue because modern scientific philosophy
> insists that testability is a requirement for the scientific method.
> This thesis of the Austrian school also gives rise to the criticism
> that it fails another basic requirement for the application of the
> scientific method, falsifiability.
>
> So long as the Austrian school sticks to these basic tenants it will
> never be useful as a scientific basis for improving the understanding
> of economics.
>
> On Jul 30 12:10 PM Hot Richard wrote:
Next step: ECB buys Treasuries with their dollar, FED buys Schatz with their euros (or whatever).
Financial media in US proclaims: high demand for US Treasuries!!
What a joke.
> However, if there are significant variations in inputs, then how
> may that affect the outcomes?
> In current circumstances, there are at least two very significant
> once in history additional factors, Peak Oil & Peak Population
> (total and Aging).
>
> Due to those factors, "this time will be different".
On Jul 31 06:20 AM prairiedog555 wrote:
> I get it, we're screwed, now why don't all of you really bright guys
> start giving all of us from the home school of economics some rational
> investment ideas, instead of sermons that show everybody how smart
> you are.
> Foreign bonds? EM debt? which ones? gold? other metals? And what
> time line? and Why.
________________________
Human beings use about 2500-3500 calories a day. Like all living creatures we need food, water, harborage and more of our own kind to survive. We most likely will regardless of oil and numbers of population. It appears that with our current tools of production and infrastructure, our, (the US), capacity to feed ourselves will continue to overproduce in relation to our needs. This surplus should continue to drive our desire and ability to “improve” our tools of production, infrastructure, harborages and quality of calories we consume. Continued investment in those areas that secure these surpluses and improvements would seem to me a worthy goal, provided above average knowledge of the item, service or device is understood by the risk taker. Wish I could be more specific Prairiedog. Personally I would stand to benefit from a greater meltdown in the economy as I have an interest in +165K oz Au CA hard rock mining claim, but these basics are hard to discount.
Austrian economics is fundamentally broken because it does not attempt progress. Without this attempt it cannot make any progress. It is a waste of time, and useless.
If it is hubris to think you can make progress, then give me a double dose of it, because in fact fact human history has been nothing more than a continuous history of such progress resulting from such hubris - from caves to walking on the moon and decoding the living gene.
People have be declaring that humans have limits since the beginning of the race. Over time there have been found to be no such limits. Medicine and chemistry were supposed to have been limited by Vitalism, aircraft could not possibly fly faster than sound,, average life expectancy will never exceed 50, and so on. The impossible of the past usually turns out to be part of daily life in the future.
Austrian economics is based on a dead-end premise and empty hope. It is a useless idea because no progress can ever come from it.
On Jul 31 07:33 AM MinAkkar20 wrote:
> Economics found in academia today is a compilation of hubris - very
> intelligent men who cannot fathom that something is outside their
> grasp. No matter how much logic and reason is stacked against them,
> they can point to a regression like it is scripture and declare an
> outcome. Look no further than the self-proclaimed learned professor
> who said students would have been wasting his time with talk about
> Austrians.
>
> That is the beauty of Austrian economics - it is the product of intelligent
> men who recognize the limits of their own capability in that they
> could never plan economic output better than a million individuals
> doing it on their own. This was an excellent article, and the most
> important line: "Mises wrote of the world as it should be. We live
> in the world as it is. Our own investment markets, or at least those
> of the supposedly developed west, are now government-directed parodies
> of free markets"
Everyone is free to believe that they can solve the economic behavior of billions of people through a regression. But nobody says there should be a means for academics to test it out in the real marketplace where people's livelihoods are at stake. You can disagree with Austrian thinking, but calling it a useless idea only shows you are close-minded.
On Aug 01 04:38 PM bricki wrote:
> Austrian economics is fundamentally broken because it does not attempt
> progress. Without this attempt it cannot make any progress. It is
> a waste of time, and useless.